Financial Statement Analysis - Ratios

profitability ratios

compare an income statement subtotal to revenue

produce a percentage often called a margin

gross profit margin

type of ratio: profitability

formula: gross profit/revenue

• note: gross profit = revenue - COGS

tells you: how much profit a company makes for each dollar of revenue

operating profit margin

type of ratio: profitability

formula: operating income/revenue

tells you: how efficiently a company is using its resources to generate profits from its core business operations

pre-tax margin

type of ratio: profitability

formula: EBT/revenue

tells you: percentage of sales a company retains as profit before deducting tax

net profit margin

type of ratio: profitability

formula: net income/revenue

tells you: net income as a percentage of revenue

EBITDA margin

type of ratio: profitability

formula: EBITDA/revenue

tells you: EBITDA as a percentage of revenue

Efficiency ratios

compare income to the capital employed by the company to generate that income

i.e. how efficient is the company at turning assets/equity into profits

Return on Assets

type of ratio: efficiency

formula: net income / avg. total assets

tells you: how am I doing in employing my assets to earn a profit → higher ROA is better

Operating ROA

type of ratio: efficiency

formula: Operating income / avg. total assets

Return on Equity

type of ratio: efficiency

formula: (net income - preferred dividends) / avg. total equity

tells you: compares the income available to common shareholders to $ invested by shareholders

• we removed preferred dividends from this model because preferred dividends detracts from the amount available to common shareholders.

conversion measures

use to analyze how cash flow differs from income

Cash to Operating Income

type of ratio: conversion measure

formula: CFO / Operating Income

Cash to Net Income

type of ratio: conversion measure

formula: CFO / Net income

Free Cash Flow Conversion

type of ratio: conversion measure

formula: FCF / Net Income

• note: FCF = CFO - CFI

A/R Turnover

type of ratio: activity ratio

formula: credit sales / average accounts receivable

tells you: how quickly accounts receivable balances are collected → higher turnover is better

activity ratios

measure how well operations are managed on a day to day basis

days in A/R

type of ratio: activity ratio

formula: 365 / (A/R)

tells you: how quickly accounts receivable balances are collected → lower days in A/R is typically better

accounts payable turnover

type of ratio: activity ratio

formula: purchases / average accounts payable

tells you: measures how quickly accounts payable are paid → lower turnover is generally better

• note: difficult because “purchases” need to be estimated which is usually defined as every transactions that gave rise rise to an accounts payable

days in A/P

type of ratio: activity ratio

formula: 365 / (A/P)

tells you: measures how quickly accounts payable are paid → higher days in A/P is generally better

inventory turnover

type of ratio: activity ratio

formula: cost of goods sold / average inventory

tells you: measures how quickly inventory is sold → higher turnover is generally better but comparisons should be made within industry

days in inventory

type of ratio: activity ratio

formula: 365 / inventory turnover

tells you: measures how quickly inventory is sold → lower days in inventory is usually better but should compare with industry standard

asset turnover

type of ratio: activity ratio

formula: revenues / average asset base

tells you: measures how effectively a company can translate assets into revenue

• note: can use a variety of “bases” in calculation (total assets (most common), current asset)

liquidity ratios

measure an organization’s ability to meet its short-term obligations

current ratio

type of ratio: liquidity ratio

formula: current assets / current liabilities

quick ratio

type of ratio: liquidity ratio

formula: (Cash + STI + A/R) / current liabilities

cash ratio

type of ratio: liquidity ratio

formula: (cash + STI) / current liabilities

solvency ratios

measure the ability of an organization to fulfill its long-term obligations

Can either measure:

• debt ratios: the amount of debt in a company’s capital structure

• coverage ratios: how the company’s income and cash flows compare to debt payments

debt-to-asset

type of ratio: solvency ratio - debt ratio

formula: debt/total assets

debt-to-capital

type of ratio: solvency ratio - debt ratio

formula: debt / (debt + equity)

debt-to-equity

type of ratio: solvency ratio - debt ratio

formula: debt / equity

financial leverage

type of ratio: solvency ratio - debt ratio

formula: average total assets / average total equity

debt-to-EBITDA

type of ratio: solvency ratio - debt ratio

formula: debt / EBITDA

interest coverage

type of ratio: solvency ratio - coverage ratio

formula: EBIT / interest payments OR

(Pre-tax CFO + interest paid) / Interest paid

ROA Decomposition

(net income) / (avg. total assets)

= [(revenue) / (avg. total assets)]

x [(net income) / (revenue)]

reminder:

total asset turnover

net profit margin

Adjusted ROA

type of ratio: efficiency

formula: NOPAT / average total assets

• NOPAT is the net operating profit after tax

• = Net income + interest expense(1 - T)

• = EBIT(1-T)

• this represents net income without the interest expense (and its created tax savings)

degree of operating leverage

% change in EBIT / % change in revenue

ROE decomposition

(net income) / (avg. total equity)

= [(net income) / (avg. total assets)]

x [(avg. total assets) / (avg. total equity)]

reminder:

ROA

leverage

3 way dupont analysis

take the ROE decomposition and apply the ROA decomposition to it to get that

ROE = net profit margin * total asset turnover

* leverage

Basic EPS

(net income - preferred dividends) / (Weighted Average Common Shares outstanding)

• denominator is weighted for the amount of time that shares have been outstanding

dividend payout ratio

dividends declared on common shares / net income

retention rate

(1 - dividend payout ratio)

repurchase payout ratio

repurchases / net income

total distribution ratio

(dividends + repurchases) / net income

CFO coverage

type: coverage

formula: CFO / net income OR CFO / Operating Income

Debt coverage

ratio: CFO / total debt

tells you: what cash is available before CFI to repay debt